Ms. Jones Goes To Washington

Hey all! So this happened. Congress had a hearing on diversity in asset management and I was asked to testify. Please see my written testimony below or check out the actual hearing at THIS LINK.

Written Testimony before the
U.S. House of Representatives, Committee on Financial Services Subcommittee on Diversity and Inclusion

Hearing: “Diverse Asset Managers: Challenges, Solutions and Opportunities for Inclusion”

Meredith A. Jones
Investment researcher and author of “Women of The Street: Why Female Money Managers Generate Higher Returns (And How You Can Too)”

June 25, 2019

Chairwoman Beatty, Ranking Member Wagner and distinguished Members of the Subcommittee, it is an honor to appear before you today at this important hearing on how to achieve greater diversity in the asset and investment management industry. 

By way of background, I am a 21-year veteran of the investment management industry. I began my investing career in 1998 at a small hedge fund firm in Nashville, TN when I was hired by a male CEO and financial services gender contrarian who believed that women made better financial analysts than men. While I worked my way up from my entry-level position as a hedge fund analyst to become the head of research and a member of the firm’s investment committee, I never doubted my boss’s hiring wisdom (although, always a fan of diverse opinions, I did eventually integrate the department to include men during my tenure). 

Employed roughly 1,000 miles from Wall Street, I did not initially realize that other asset management and investment firms had far less gender diversity than mine. In fact, it wasn’t until I started regularly speaking at investment industry conferences (where I was often one of few, if not the only, female speaker) that I began to recognize how little gender and racial diversity existed in my chosen profession. I began to research diversity in asset and investment management in 2010 and, over the past nine years, have come to appreciate just how unique my investment “upbringing” was, as well as how unlikely it would have been for me to be sitting here today without my original boss’s unorthodox hiring preferences. However, even with that leg up, admittedly it has been a rather solitary career path, with few diverse role models, mentors, and sponsors along the way. 

As challenging as the lack of diversity may have made my personal journey, that pales in the face of the systemic cost of homogeneity in asset management. In fact, nine years of research has left me with the unshakable knowledge that the lack of women and minorities in the asset management and investment industries is making everyone, from Wall Street to Main Street, poorer. 

While this may be a bold statement, I believe a number of factors support the assertion that, as a society, we are missing out on a “diversity dividend.” 

1)    A wealth of investment research suggests that diverse asset managers may provide similar or even higher returns. Studies from the NAIC[1], CityWire[2], BarCap[3], Babalos[4], Morningstar[5], Rothstein Kass[6] and others show that diverse fund manager performance (either within separate funds or in mixed gender teams) is at least equal to and, in many instances, greater than that of the total investment fund universe. A 2016 study by Oleg Chuprinin and Denis Sosyura found that hedge funds run by individuals that grew up poor (bottom 20 percent of households in terms of wealth) outperformed those managed by managers from the top 20 percent by over 1 percent per year[7]. A 2019 study from Harvard University’s Bella Research Group further found that women and minority owned hedge funds, mutual funds and private equity firms had disproportionate representation in top quartile performance figures[8]. Another Harvard study found[9] that the chance of a venture capital-backed company filing for an Initial Public Offering increased by 20 percent if the backing investors were from different ethnic backgrounds, while venture capital firms that “increased their proportion of female partner hires by 10% saw, on average, a 1.5% spike in overall fund returns each year and had 9.7% more profitable exits,” again per a Harvard Business Review study[10].

These studies and others like them strongly suggest that investors, from the wealthiest of individuals to the police, firemen and teachers that depend on well-invested pension portfolios, may in fact have inadequate financial resources due to lack of access to diverse investment talent.

 2)   Access to diverse asset management talent may provide another diversification tool within portfolios, and may also help mitigate volatile market behavior, which is currently dominated by a single cognitive and behavioral pattern. At least one study has found that having more women on Wall Street could reduce market volatility[11] due to the introduction of differentiated investing behavior. Another review by investing platform Stash found men 87% more likely to sell[12] during periods of market volatility, which means diversity potentially provides both stability and liquidity in the markets. Furthermore, Hedge Fund Research’s Diversity Index (HFRI Diversity Index[13]) has posted a flat return (0.00%) over the last 12 months, which compares favorably to the HFRI Fund Weighted Index -1.24% loss in value over the same period, further evidence of return diversification. 

In addition, according to the National Association of Investment Companies (“NAIC”), one reason for outperformance of diverse private equity managers may be differentiated deal flow. The report concludes[14] that “[m]any diverse fund managers have educational and work experience similar to investors in non-diverse funds. However, some also report having expanded, differentiated networks that allow for deal flow off the beaten path.To the extent that a fund manager has access to such deal flow and can strike deals with less competition, their returns, and investors, may benefit. For example, firms and funds focused on the EDM may have access to companies on the cusp of growth due to changing demographics and shifts in the global economy.” 

Despite clear advantages to cognitive and behavioral diversification, some estimates indicate that as many as 95% of those taking risk with capital on Wall Street and in the asset management industry are white males, and we certainly know from a variety of sources that asset and investment management generally lacks diverse participants in any meaningful way. For example, per the Bella Research Group study[15] referenced above, “the number of substantially or majority diverse-owned funds represented just 8.6 percent of the total in 2017” and women-owned firms managed a mere 0.8% of all assets under management while minority-owned firms controlled 1.2% of fund assets. Leaving fund ownership aside, a 2017 review of the alternative investment industry by Preqin[16] found that women comprised less than 21% of all employees in private equity, venture capital, hedge funds, real estate, infrastructure, natural resources and private debt funds, and that, of these employees, only 11% (or less depending on the asset management segment measured) occupied senior roles. And TechCrunch reported that 81%[17] of venture capital firms don’t have a single black investor. 

3)   Concentration of venture capital investments into similar companies perpetuates unmet consumer needs and lack of investment and jobs into diverse and underserved communities.It has been repeatedly shown that the East and West Coasts dominate the venture capital landscape, with the Bay Area and the New York-Washington-Boston corridor landing an astonishing two-thirds of all venture capital investment[18]. This creates a vast, unexplored economic desert throughout much of the continental United States. In addition, female founders received just 2.2%[19] of all venture capital in 2017 and 2018, while from 2007 to 2012 black and Hispanic founders each received about 1%[20] each in venture capital investments. These statistics are both stark and critical for understanding lost economic opportunities. 

Women influence 83% of consumer spending and $7 trillion of spending[21] in the U.S. annually, and consumer spending drives an ever-increasing percentage of the GDP,and yet women’s needs currently may not be met by venture-funded companies. A study by Neilson found[22] that “African American income growth rates outstrippednon-Hispanic whites at every annual household income level above $60,000and the largest increase for African American households occurred in the number of households earning over $200,000, with an increase of 138%.” Yet, their consumer needs may not be represented by current venture-capital funded companies. And “between 2016 and 2017, Hispanics increased their real median income by 3.7 percent[23], the highest of any demographic.” 

The lack of funding outside of traditional money centers as well as the near exclusion of diverse founders represents a tremendous lost opportunity for investment, economic expansion and job creation in diverse and underserved communities. Additionally, this compounds the lost opportunities for higher investment return generation, where less competition for portfolio companies creates more reasonable valuations for investors. 

In my opinion, these three factors lead to one powerful conclusion: Diversity pays a dividend in asset management, one that, at least with the status quo, we have no hope of collecting. 

To address the continuing lack of diversity in asset and investment management, I believe we need to focus on educating three primary groups:

 1)   Investors– With pension liabilities funded at only 73.7%[24] and with an astonishing 78% of Americans extremely or somewhat concerned about being able to comfortably retire[25], it is critical that the return enhancement and diversification benefits available through investment with diverse asset managers be highlighted and pursued. After all, demand from investors almost always drives innovation and change on Wall Street.

2)   Asset and Investment Management Firms– While investors stand to reap the benefits of higher returns, asset managers and investment firms will profit as well through higher income from fee generation. In addition, firms that maximize diversity for returns and diversification may be able to capture a higher percentage of investable assets as investors seek higher return products. Companies that understand how the “diversity dividend” can directly impact their bottom line are more apt to support educational efforts in pre-hire cohorts, recruit diverse talent, uncover and mitigate unconscious bias in hiring and promotion decisions, and provide mentoring, sponsorship and affinity groups as part of a robust inclusion effort. Finally, given the generational wealth transfer taking place to diverse individuals (and the gains in diverse economic status cited above), failure to serve these demographic groups as a client base will almost certainly take a toll on asset and investment manager profitability in the future, further prioritizing this issue. 

3)   Diverse individuals– Providing financial and investment literacy education to girls and people of color at a young age (high school or earlier) is critical to building a pipeline of qualified diverse asset management candidates. For example, studies have shown that girls opt out of math-related subjects as early as age 11 or 12[26], meaning that it is not sufficient to intervene at the college or graduate school level, when qualified candidates have already self-selected into other academic areas. As a board member for a non-profit that provides financial education to girls (with 69% minority representation), I can say that Rock the Street Wall Street sees a 97% increase in understanding of financial concepts and, perhaps most importantly, 67% of the girls indicate they are now extremely or very likely[27] to explore a major or minor in finance and economics. This type of early intervention is therefore beneficial in building a pipeline of talent for companies and investors, and of course benefits diverse asset management talent as well.

In conclusion, I certainly recognize that diversity in asset management is a complex and costly issue. It is one that has no single, simple solution as it ultimately springs from historical and ongoing conscious and unconscious bias, as well as access to opportunity, education and capital. I do believe, however, that through robust public-private educational partnerships, common-sense transparency requirements (to both measure progress and so investors can adequately assess the level of alpha-generating diversity at asset management firms) and suitable anti-discrimination and harassment statutes, we can change the face of asset management for the future, and enhance the economic well-being of both Wall Street and Main Street in the process. 

[1]http://naicpe.com/wp-content/uploads/2017/10/2017-performance-report.pdf

[2]https://citywireselector.com/news/alpha-female-2018-mixed-gender-teams-produce-better-returns/a1145784

[3]https://www.managedfunds.org/industry-resources/industry-research/affirmative-investing-women-and-minority-owned-hedge-funds-a-barclays-capital-report/

[4]https://www.sciencedirect.com/science/article/pii/S0275531915000264

[5]https://www.fa-mag.com/news/morningstar--the-gender-lens-doesn-t-magnify-your-bottom-line-37579.html

[6]https://www.managedfunds.org/industry-resources/industry-research/women-alternative-investments-marathon-sprint-rothstein-kass/

[7]http://webuser.bus.umich.edu/dsosyura/Research%20Papers/FamilyDescentDec2016.pdf

[8]https://kf-site-production.s3.amazonaws.com/media_elements/files/000/000/281/original/2019_KF_DIVERSITY_REPORT-FINAL.pdf

[9]https://hbswk.hbs.edu/item/in-venture-capital-birds-of-a-feather-lose-money-together

[10]https://hbr.org/2018/07/the-other-diversity-dividend

[11]https://www.aeaweb.org/articles?id=10.1257/aer.20130683

[12]https://qz.com/work/1386775/study-of-investors-shows-differences-between-men-and-women/

[13]https://www.hedgefundresearch.com/family-indices/hfri

[14]http://naicpe.com/wp-content/uploads/2017/10/2017-performance-report.pdf

[15]https://www.institutionalinvestor.com/article/b1cwvq3mc37xwk/Asset-Managers-Owned-by-Women-and-Minorities-Have-to-Work-10X-as-Hard-for-Assets

[16]https://docs.preqin.com/reports/Preqin-Special-Report-Women-in-Alternative-Assets-October-2017.pdf

[17]https://techcrunch.com/2018/11/08/81-of-vc-firms-dont-have-a-single-black-investor-blck-vc-plans-on-changing-that/

[18]https://www.citylab.com/life/2017/10/venture-capital-concentration/539775/

[19]http://fortune.com/2019/01/28/funding-female-founders-2018/

[20]https://money.cnn.com/2016/04/12/smallbusiness/latino-venture-capital/index.html

[21]http://www.genderleadershipgroup.com/the-inclusionary-leadership-blog/210

[22]https://www.nielsen.com/us/en/insights/reports/2015/increasingly-affluent-educated-and-diverse--african-american-consumers.html

[23]http://hispanicwealthproject.org/resources/blog/new-hispanic-wealth-project-report-confirms-critical-role-of-hispanics-in-u-s-economic-growth/

[24]https://www.bloomberg.com/graphics/2018-state-pension-funding-ratios/

[25]https://news.northwesternmutual.com/2018-05-08-1-In-3-Americans-Have-Less-Than-5-000-In-Retirement-Savings

[26]https://techcrunch.com/2016/01/05/why-stems-future-rests-in-the-hands-of-12-year-old-girls/

[27]https://rockthestreetwallstreet.com

Your Fund Is Grossing Me Out!

I was roughly 13 years old when I fell for Nicolas Cage in Valley Girl. Between the Modern English montage of soda sharing and late-night phone calls (on corded phones and pay phones!) and the bitchin’ clothes and slang, my tweenage heart sang just a little for Hollywood punk Randy.  In fact, if not for that movie, I doubt the phrases “Tubular!” and “Gag me with a spoon” would have ever made an appearance in my semi-rural Alabama hometown, even if the latter is what Northerners often think out loud when trying grits for the first time.

Although American slang has come a long way since 1983, I do still find myself using the phrase “gross me out!” on occasion. Weirdly, I almost never say it in reference to Martha Coolidge’s marvelous flick, but it does pop up in conversations with asset managers from time to time.

That’s right, if you’re a fund manager who has marketed your separate account, hedge fund or other offering, there’s a reasonable chance your pitch book might have barfed me out. Why? Gross returns, y’all. And I’m not talking about actual performance losses.

So many fund managers continue to show gross returns in their pitch books, and it makes me want to yell “Grody to the max!” during many a manager’s pitch. 

Per GIPS standards gross-of-fees returns are “the returns on investments reduced by any trading expenses, including transaction expenses for real estate and private equity incurred during the period” while net-of-fees returns are defined as “the gross-of-fees returns reduced by investment management fees (including performance-based fees and carried interest).” GIPS goes on to say in another memo that “because fees are sometimes negotiable, presenting gross-of-fees returns shows the firm’s expertise in managing assets without the impact of the firm’s or client’s negotiating skills. Accordingly, firms are recommended to present gross-of-fees returns.”

Bag. Your. Face.

Look, I know I’m no one and GIPS is, well, GIPS. But seriously? It seems to me that showing net returns is the best measure of investment prowess since it proves you can (or can’t) both execute your investment strategy AND I dunno, put food on the table and pay your office rent, too. 

Also, gross returns aren’t what an investor can actually attain in your fund since, and I’m just spitballing here, you probably aren’t going to start managing money for free. So, to be honest, gross returns are kind of like showing an investor something totally rad and then yelling “psych!” 

Believe me, I do understand why managers may want to show the gross returns. Because they are net of fees they are, by definition, higher than net returns. They make you look so much more, like, gnarly (in the good way). But because the Securities and Exchange Commission generally asserts managers should show performance results net of fees (except in certain limited instances as defined by the Clover letter, for example) I find many fund managers succumb to both GIPS and the SEC guidance by showing investors gross AND net returns. Which, to me, is the worst of all possible worlds. 

I mean, what better way to show an investor why cheaper is better, why they should negotiate their buns off for the lowest fee level possible or, I dunno, even just say screw it and go all passive or smart beta on you? Like, “here’s what you could have gotten if I wasn’t making money off you, Investor. But neener neener neener.” 

And since, again per GIPS, “…firms are not specifically required to present gross-of-fees or net-of-fees performance but are allowed to present either, or both with equal prominence, as long as the returns are clearly labeled and accompanied by the required disclosures to help the prospective client understand how the measure(s) have been prepared” MAYBE, just maybe, you should consider showing the returns that offers the best proof of your worth and value as an active manager. I mean, wouldn’t that be totally radical, y’all? 

I did get over my Nicolas Cage crush, by the way, and well before the disastrous mullet/wife beater combo of 1997’s Con Air, but I for sure continue to have just a tiny bit of Valley Girl in my redneck roots. And I’m begging you all: Stop grossing me out!

Whip It Good

I recently started training to become a roller derby referee.

You read that right. In my spare time, I plan to sport a really loud whistle and to wear a black and white striped shirt with my chosen roller derby moniker emblazoned on the back. Bonus points for the loyal reader who guesses what that might be.

You see, I’ve been a fan of roller derby for years. I loved the movie “Whip It” and, shortly after seeing it for the first time, discovered that Nashville has its own Rollergirls team. I’ve been going to bouts ever since. Mock me if you will, but I would argue that there are few better evenings of sports entertainment to be had. It’s cheap. There are nachos and beers bigger than my head. In addition, roller derby names bring in a hefty dose of humor - one opposing team actually had a player named, I kid you not, “The Other White Meat.” Basically, it’s all around good, clean fun, with just a hint of sex and violence. How can you lose?

On my first night of official practice, I realized that all of my beer-fueled nights of watching roller derby had ill prepared me for actual officiating. While I was familiar with the basic rules, there were dozens of arcane guidelines that one would never notice from the stands. For example, a player sitting or standing in the penalty box can remove their mouthguard, but if they skate towards the track with it out, that’s a penalty. Skaters choose their own one- to four-digit player number, which are always said as individual digits (Player 1-3-3-7 versus Player 13-37). Luckily, breaking that rule won’t earn you a penalty, but it may merit a dirty look from a player named Winona Thud. 

(c) 2009 Mandate International "Whip It"

Some of the rules, particularly ones I kept screwing up, seemed a little silly to me, and, being the Type A jerk I can sometimes be, I felt compelled to question a few. That earned me a few additional dirty looks. At one point the head official said, “yeah, it’s kind of peculiar, but that’s just the way it is.”

After I got home that night, I started thinking about the arbitrary rules in other parts of my life. Investing obviously has A LOT of very specific rules and regulations, most of which have been handed down by various regulatory bodies. Some of them make perfect sense to me (providing net versus gross performance to current and potential investors, for example), while some seem designed merely to make me crazy and to create and sustain compliance jobs.

But in addition to the codified (and omnipresent) regulations in investing, there are a host of informal norms and mores, as well as some basic unspoken tenets. And, at the end of the day, understanding the entire greasy burrito of investing lore is critical to navigating investment terrain without losing your sanity.

For example, even though there’s no rule (or glaring Rollergirl named “Lil Red Right Hook”) to dissuade them, most managers know by now NOT to make their pitch book too long, but what about color schemes? Did you know you generally shouldn’t have a red logo or typeface (red connotes losses)? And make sure you get in front of investors, but realize that you’re probably going to be judged if you’re out and about at conferences and events too often (who’s minding the portfolio?). Follow up but don’t be pushy, oh and, by the way that fine line may vary from investor to investor. Don’t let an investor read bad news in the press. And so on.  And so forth.

Most of us that have been in the industry for long enough have digested these kinds of particulars and therefore navigate the industry fairly seamlessly. But I still often see one great divide between investors and managers when it comes to the accepted rules of play, and it has to do with the starting line.

Many investors approach investing from a place of “no,” while many, if not all, fund managers, approach investors from a place of “why the hell not?”

A fund manager may think: Why wouldn’t an investor want to talk about my fund with me? Why wouldn’t an investor trust me with their capital? Why wouldn’t I deliver satisfactory results? Why wouldn’t this strategy make sense right now? Why wouldn’t an investor want to buy on a drawdown – buy low, sell high, right? Why wouldn’t an investor have liquid funds to allocate to me now? If I just keep up the conversation, I know they’ll eventually come around. I know there are a lot of funds out there, but this is just one more, right?

An investor may think: This is the 20th long-short equity (core fixed income, SMID-cap) fund that’s contacted us this month. That manager lost a lot of capital at a prior fund. That fund doesn’t have the right infrastructure. That fund is too small to safely absorb our investment. That fund has too little capacity for us to scale up appropriately. That manager has been underperforming of late – there’s headline risk and career risk, and what if it’s not a buying opportunity but a sign that the manager isn’t talented? That’s a strategy we’re not interested in/over-allocated to right now. We’re using mostly passive investments for that part of the portfolio. We don’t have liquidity to make new investments without redeeming from existing investments. I don’t know how many more times I can tell this fund no. There are thousands of funds out there, and this is just one more.

Even though it’s frustrating, even though the response you get may not be the one you think you deserve (or what you think you’d do in the other person’s shoes), even if you don’t like it, that’s just the reality of the investing world. And it’s really important to have a little empathy about the realities on the other side of the fence. It can save you time, energy and perhaps even a little time in the penalty box. 

Good Riddance 2016, Hello 2017!

Well, 2016 has been one helluva year. Between the celebrity deaths (Bowie, Rickman, Prince in particular), fake news, election chaos, Zika, creepy clowns, Aleppo, and a host of other miserable events, I know I won’t look back on 2016 with anything remotely regarding fondness. In fact, I may pretend this year didn’t even happen, therefore reducing any future therapy bills and bolstering lies about my real age.

But alas, as much as I wish I could be Queen of de-Nile, I’m afraid 2016 did happen, and I have the blogs to prove it.

So if you need a good year-end chuckle to survive the holidays, the Electoral College vote, or your boozy office fete, or if you’re just craving random info and snarky rants about the investment industry, I’ve got just what the doctor ordered.

Here’s a complete wrap up of all my blog postings, by topic, for 2016. Enjoy them while you rock around the Christmas tree, drink your Gin and Tonica, or however you plan to celebrate the season.

See y’all next year!

Hedge Funds (Don’t) Suck

http://www.aboutmjones.com/mjblog/2016/11/1/killer-kittens-the-decline-of-hedge-fund-returns (Why you’re more likely to be injured by your toilet than get busted by the SEC)

http://www.aboutmjones.com/mjblog/2016/9/6/you-cant-handle-this-hedge-fund-truth (Perception versus reality in the world of hedge funds, told with pictures)

http://www.aboutmjones.com/mjblog/2016/5/17/hedge-fund-truth-dont-believe-everything-you-read (Animated blog about hedge fund fees, returns and the so-called talent shortage)

http://www.aboutmjones.com/mjblog/2016/2/29/the-hedge-fund-headline-predictorator (Using hedge fund headlines (13-Fs, Rich List, etc.) to tell time and seasons)

http://www.aboutmjones.com/mjblog/2016/2/22/person-or-people (Why we tar the investment industry with a big brush, and how that can hurt performance in the long run)

http://www.aboutmjones.com/mjblog/2016/9/20/can-this-hedge-fund-relationship-be-saved (The hedge funds people fell in love with 2000 to 2002…well, they’ve changed…)

Behavioral Finance

http://www.aboutmjones.com/mjblog/2016/8/16/thank-god-what-you-see-isnt-all-there-is (The bias of “what you see is all there is” and why that makes us think returns are lower than they are)

http://www.aboutmjones.com/mjblog/2016/7/19/great-expectations (Matching investor expectations to reality. Matching money manager expectations to reality)

http://www.aboutmjones.com/mjblog/2016/8/2/a-picture-is-almost-worth-1000-words (Truly terrible drawings that illustrate the “streetlight effect” and how we end up looking in the wrong place for strong performance)

Diversity And Investing

http://www.aboutmjones.com/mjblog/2016/11/15/lenny-bruce-is-not-afraid (A post election blog that covers the importance of diversity, ESG, thinking before you talk to investors and a long-term investment strategy)

http://www.aboutmjones.com/mjblog/2016/7/5/and-now-for-something-completely-different (How cognitive, behavioral, structural and network diversity can benefit investors in hedge funds, private equity and venture capital)

http://www.aboutmjones.com/mjblog/2016/6/7/the-five-ps-of-gender-parity (Solutions for getting more women into the investment industry)

http://www.aboutmjones.com/mjblog/2016/1/25/no-quick-fix  (The many unconscious biases men AND women have to overcome to achieve gender parity in investing)

http://www.aboutmjones.com/mjblog/2016/1/4/nostradamnus  (Why the low return environment heading into 2016 may require some creativity on the part of investors re: active management, diversity, and emerging managers)

Emerging Managers and/or Capital Raising

http://www.aboutmjones.com/mjblog/2016/12/6/the-five-stages-of-emerging-manager-grief (Denial, anger, bargaining, depression and acceptance all figure into your capital raising experience)

http://www.aboutmjones.com/mjblog/2016/10/4/seed-me-seymour (The truth and consequences of seed capital)

http://www.aboutmjones.com/mjblog/2016/7/5/and-now-for-something-completely-different (How cognitive, behavioral, structural and network diversity can benefit investors in hedge funds, private equity and venture capital)

http://www.aboutmjones.com/mjblog/2016/6/21/capital-raising-crimes-punishment (Don’t be guilty of these capital raising crimes or pay the price of low AUM).

http://www.aboutmjones.com/mjblog/2016/4/5/are-you-hot-or-not (Evaluating a new fund launch – what makes some sizzle and others fizzle?)

http://www.aboutmjones.com/mjblog/2016/2/14/at-your-service (Choosing your service providers)

http://www.aboutmjones.com/mjblog/2016/1/31/making-the-first-move (How to make and keep contact with investors without making them hate you)

http://www.aboutmjones.com/mjblog/2016/1/4/nostradamnus (Why the low return environment heading into 2016 may require some creativity on the part of investors re: active management, diversity, and emerging managers)

Random Musings

http://www.aboutmjones.com/mjblog/2016/11/15/lenny-bruce-is-not-afraid (A post election blog that covers the importance of diversity, ESG, thinking before you talk to investors and a long-term investment strategy)

http://www.aboutmjones.com/mjblog/2016/1/18/money-manager-advice-dont-panic-but-do-bring-a-towel (What 2016 may bring - fee pressure, market volatility, few changes to the regulatory regime until after the election)

http://www.aboutmjones.com/mjblog/2016/5/3/kicking-the-buckets (Do strategy and style buckets help or hurt us? Getting past a checkbox mentality)

http://www.aboutmjones.com/mjblog/2016/4/18/you-are-so-money (Money manager horoscopes - don’t ask!)

http://www.aboutmjones.com/mjblog/2016/3/14/money-manager-report (How to effectively evaluate money manager performance without getting caught up in your benchmark underpants.

http://www.aboutmjones.com/mjblog/2016/10/18/sleepless-in-nashville (The things about the investment industry - hedge funds, private equity, venture capital, real estate, investment advisors, etc. - that keep me up at night)

http://www.aboutmjones.com/mjblog/2016/1/4/nostradamnus (Why the low return environment heading into 2016 may require some creativity on the part of investors re: active management, diversity, and emerging managers)

ESG/Socially Responsible Investing

http://www.aboutmjones.com/mjblog/2016/11/15/lenny-bruce-is-not-afraid (A post election blog that covers the importance of diversity, ESG, thinking before you talk to investors and a long-term investment strategy)

http://www.aboutmjones.com/mjblog/2016/2/7/ucee2gr6omdig0e5vtpsbx8qra738m (Predicting more interest in socially responsible/ESG investing, different pathways to fund management jobs, and a break from paper and PDFs)

Lenny Bruce Is Not Afraid

November has been, at least thus far, a month of surprises.

You know that curse on the Chicago Cubs? Surprise! They won the World Series.

Didn’t I just see a Facebook post on a local norovirus (aka the stomach flu) outbreak? Surprise! I temporarily had to rename myself Vomitola Khomeni – and finally found that button I ate when I was three…

Hey! Do you remember all those polls that showed Democrat Hillary Clinton easily winning the White House? Surprise! Donald Trump is the 45th President of the United States.

Oh, and of course you recall all the dire predictions for the stock market should Donald Trump win the presidency? Surprise! The Dow Jones Industrial Average was trading in record-making territory a mere two days later.

To be honest, while I did spend much of the first part of the week “enjoying” my virus-induced weight loss opportunity, I also, if somewhat dimly and feverishly, realized that collectively we have done a terrible job of predicting recent events.

I know many in the financial industry had to have been stunned and dismayed by the election results. According to an October 26, 2016 article in Fortune, Trump raised $239,250 from hedge fund and private equity firms, while Hillary Clinton raised $45.2 million from the same groups. Charles River Ventures, a Silicon Valley venture capital firm even went so far as to entitle a blog posting “F*CK TRUMP.” Even though Republicans in other races enjoyed healthy and widespread financial industry support, it just wasn’t there for Trump.

As a result, for many people, last Wednesday morning must have seemed like the end of the world (as we know it). And while I didn’t notice any birds, there were even “snakes and aeroplanes” for any still doubting the seriousness of the situation. (https://www.theguardian.com/environment/2016/nov/08/snake-on-a-plane-passengers-flight-mexico-city) 

So where do we go from here? How does the investment industry successfully navigate the new normal and survive and thrive in a new world order? Here are a few thoughts I had that may help investors and managers both do good while they do well.

One: Don’t Say Or Write Anything That Endangers Your Current AUM

This was a contentious election. Combative. Testy. Belligerent. Factious. Antagonistic. Insert every single synonym for “unpleasant and argumentative” you can come up with here, because no matter how you slice it, the 2016 political campaign was a dumpster fire, starting with the Republican and Democratic primaries and continuing through the general election. It. Was. Not. Pretty.

As a result, there are a lot of very strong post-election feelings on both sides of the aisle.

And as we extend our personas over Facebook, Twitter, Blogs, Instagram and other platforms, there has simultaneously been a reduction of social restrictions and inhibitions known as the “Online Disinhibition Effect.”  It makes us more likely to say, write or post things that we likely wouldn’t have before.

When you combine those things – deep disappointment, hurt feelings and increased disinhibition – you end up with an improved likelihood of offending someone, inadvertently or otherwise. And when you seriously offend a client or prospect in this industry, your AUM suffers.

So lock down your Facebook account if you post politically on it. Don’t assume you know what someone’s views may be unless they’ve actually told you what their views are. In fact, to the extent that politics and social issues don’t impact your investment strategy or portfolio, don’t talk about them in professional settings. At all. Better safe than sorry because it’s easier to keep a client/investor than to acquire a new one.

Don’t believe me on this one? Ask Matt Maloney, who’s firm, GrubHub, suffered share price losses of 9.4% in the two days after the election over a leaked internal communiqué. Shut. It.

Two: Consider Diversity In Hiring and Investing

This election cycle has been, at least in part, about disenfranchisement. Trump likely won the election due to the disenfranchisement of the white, working class rural voter, while those who fear pending disenfranchisement (minorities, women, immigrants, LBGTQ) have fueled protests post-election.

The good news for investors and money managers is that inclusion will ease disenfranchisement, and it can also make everyone richer, too. Here’s how:

• Deszo & Ross studied the effect of gender diversity in the S&P 1500 and found that “female representation in top management leads to an increase of $42 million in firm value.”
• Orlando Richard found in his study that for “innovation-focused banks, increases in racial diversity were clearly related to enhanced financial performance.”
• Catalyst found that Fortune 500 companies with the highest representation of women board directors had significantly higher financial performance than those that don’t.
• Morningstar found that mixed-gender mutual fund teams outperformed single gender teams.  
• The HFRI Diversity Index (+4.21%) has outperformed both the HFRI Fund Weighted (+3.59%) and HFRI Asset Weighted (1.31%) indices for the year to date through October.
• In a paper by Stanford professor Margaret Neale, diversity and intellectual conflict proved good for organizations. “When…newcomers were socially similar to the team, old team members reported the highest level of subjective satisfaction with the group’s productivity. However, when objective standards were measured, they performed the worst on a group problem-solving task. When newcomers were different, the reverse was true. Old members thought the team performed badly, but in fact it accomplished its task much better than the homogenous group.”
• Diversity includes “Functional Diversity” or “the extent to which individuals frame problems and go about solving them.” As a result, age, background and life experience should also be considered aspects of the diversity equation.

Certainly, in a rapidly changing world, having better problem solving skills and potentially better returns has to be a good thing, right? So cast a wide net when hiring staff or money managers going forward to maximize your cognitive alpha.

Three: It’s Still A Great Time To Focus On ESG Factors

So, early reports have the newly-elected administration throwing out both the Environmental Protection Agency and the CFPB, as well as doing away with Dodd-Frank, among other regulatory changes. While it’s too early to know whether and when that can or will happen, there are a few things we do know:

• 49% of high net worth (HNW) millennials (yes, they exist!) say that social responsibility is a consideration in investing. 53% of all millennials agreed. 43% of HNW GenX also consider social responsibility in investing. Due to demographic shifts in the workplace (these groups of workers are now larger than Boomers) and the looming generational wealth transfer, it probably makes sense to develop products that cater to these interests sooner rather than later.
• Bauer, Frijins, Otten and Tourani-Rad found “well-governed firms significantly outperform poorly governed firms by up to 15% a year” in their paper “The impact of corporate governance on corporate performance: Evidence from Japan.”
• A Wharton paper from 2012 shows a “positive association between corporate governance and performance…and evidence that higher corporate governance leads to an increase in cash dividends.”
• Exxon spent $2.1 billion cleaning up the spill from the Exxon Valdez, which, while recoverable, ain’t great for a company’s bottom line.
• Wells Fargo’s recent governance gaffe could cost the company up to $4 billion in revenue.
• GrubHub’s “hostile workplace” internal email has led to a boycott and a drop in share price.

It seems reasonable that ignoring ESG factors can cost you both potential returns and clients, and possibly increase portfolio risks. And even if there aren’t dedicated regulations or government bodies watchdogging, it also seems reasonable to assume that many investors (and the markets) WILL still care.

Four: Don’t Make Any Sudden Investment Moves

The Sunday before the election, I had a sudden Han Solo moment (“I’ve got a bad feeling about this…”) and decided that I needed to think about buying an inverse S&P ETF. I gave myself 24 hours to ponder and ultimately decided to stay my current course and not change anything in my investment portfolio. Lucky me, right? That single choice would have cost me. Bigly.

Humans want certainty. In a study published in Nature Communications, knowing there is a small chance of getting an electrical shock causes more stress than knowing you’ll be shocked.

Shocking!

But seriously, when you’re feeling uncertain about your investment strategy, take a moment. Take a walk. Take a breath. Take a sip. Take whatever step back you need before making any sudden investment decisions. Whether you’re an investor or a money manager or just a Star Wars fan with a retirement account, it’s important to remember that we generally invest for the long-term. Don’t risk your long-term goals chasing short-term “certainty.”

As for me, I’m taking my own advice. Right after I get back to my 80s roots, dig out my mismatched Converse high-tops from the very back of the closet, and have a 3-minute R.E.M.-party to dance it out. I invite you all to do the same.

Sources: http://fortune.com/2016/10/26/trump-hillary-clinton-hedge-fund-campaign-finance/

http://seekingalpha.com/news/3223875-grubhub-minus-5_8-percent-following-ceos-anti-trump-commentary

https://www.scientificamerican.com/article/how-diversity-makes-us-smarter/

http://www.catalyst.org/media/companies-more-women-board-directors-experience-higher-financial-performance-according-latest

http://corporate.morningstar.com/US/documents/ResearchPapers/Fund-Managers-by-Gender.pdf

https://www.hedgefundresearch.com/family-indices/hfri#

https://www.gsb.stanford.edu/insights/diverse-backgrounds-personalities-can-strengthen-groups

https://www.ncwit.org/resources/how-can-organizations-recruit-diverse-talent-ways-promote-innovation-and-productivity/how

http://fic.wharton.upenn.edu/fic/papers/12/12-14.pdf

http://www.evostc.state.ak.us/%3FFA=facts.QA

http://www.cnbc.com/2016/10/24/wells-fargo-fallout-could-tally-4-billion-dollars-in-revenue-up-to-30-percent-customer-drop-study-says.html

https://www.ucl.ac.uk/news/news-articles/0316/290316-uncertainty-stress

Killer Kittens & The Decline of Hedge Fund Returns

In September of this year, a curious story started making the rounds on my Facebook feed. It seems that the CDC had underestimated the rate of cat scratch disease among the general population, determining that it was both more common and perhaps more severe than previously thought.

Folks in my feed freaked. The EFF. Out.

It can’t be! Little Fluffy how could you?!?

People on Facebook (and some media outlets) actually started asking questions like:

“Are you still willing to own a cat??”

“What about kittens? You can’t get a kitten now! They are even more prone to spreading the disease!”

“What if you have kids? Children 5-9 are most susceptible!” 

Folks took special care to ensure the story hit my feed. As a crazy cat lady, they wanted me to both forewarned and forearmed.

And my reaction? After I got done singing “They give me Cat. Scratch. FEVER!” in my best Ted Nugent-esque voice, I laughed my cat-fur dusted butt off.

I’m guessing no one really made it past the headline of the article to see that the actual chance in contracting cat scratch disease was 5 in 100,000. That’s right, you have a better chance of injuring yourself in a “toilet related incident” (1 in 10,000) than you do of contracting cat scratch FEVER. Buckets and pails injured 11,000 people in 1996 (about the same number of folks that get cat scratch FEVER annually). Hell, air fresheners caused 2,600 injuries one year.

Y’all have seen the Darwin Awards - you know just about anything can be dangerous in the wrong hands.

But no, because people are well on their way to black belt status when it comes to specious claims and spurious correlations, somehow deadly kittens were news.

I had almost the same reaction (minus the Ted Nugent rocker style) two weeks ago when I came across the Bloomberg article “Hedge Fund Woes After U.S. Crackdown Don’t Surprise SEC’s Chair.” In it, the author notes that hedge fund returns have “fallen off a cliff “ since regulators and prosecutors cracked down on insider trading. Mary Jo White was quoted as saying “I don’t think anyone would argue that some of those returns at some hedge funds, and I don’t want to paint with too broad a brush, can be attributable to obviously trading on insider information that one is not allowed to trade on.”

The article then goes on to compare HFRI Equity Hedge returns to the S&P 500 November 2002-September 2009 and November 2009 to September 2016. Not sure what happened to October 2009, but whatevs.

Oh my. Where to even start?

I suppose the start of the SEC insider-trading crackdown could be traced to the charges filed against Raj Rajaratnam of Galleon in October 2009, which would account for the rather odd time period selection in the article.

However, information on insider trading enforcement actions seems to indicate that the number of actions was largely stable until 2015, hovering right around an average of 51, until a spike to 87 enforcement actions occurred in 2015. 

(c) 2016 MJ Alts. Data from www.sec.gov. 

I suppose you could say that high-profile hedge fund enforcement actions from 2009 on acted as a deterrent industry-wide. One could argue that fear of insider trading actually curtailed insider trading. All the compliance training, videos, quarterly disclosures, CCO reviews and whatnot that were instigated in the wake of SEC activities kept hedge fund managers too honest to continue their pernicious investment activities post-Raj's 2009 arrest.

Although, to be fair, compliance is generally designed to catch honest people. Money managers' who genuinely want to rip you off? They'll find a way to do so, compliance or not.

But regardless, I might argue that any crackdown that has occurred happened not in 2009, but in 2015 (a 70% increase in insider trading enforcement actions from the prior 10-year average is definitely notable), when, let’s remember, the S&P 500 lost 0.7% (without dividends reinvested) or gained a whopping 1.2% (with dividends reinvested), depending on your point of view. During the same period, the HFRI Fund Weighted Composite lost 0.85% (net), which makes performance during the actual crackdown time period a virtual tie, no?

Furthermore, HFR reported that 55% of funds posted gains that year. So maybe up to 5,500 funds were still engaging in insider trading, despite the crackdown and widespread compliance terror? Oh, and the funds listed in this Bloomberg article (http://www.bloomberg.com/news/articles/2016-02-23/the-top-performing-hedge-funds-of-2015), well I guess they were all tripping with the tipsters, too?

That’s a LOT of alleged (implied?) insider trading, my friends. A lot more than the actual 87 insider trading enforcement actions that took place that year. I guess all 87 of those enforcement actions must have been hedge funds, right?

Yeah, no.

According to an SEC publication on 2015 activities, “notable” examples of insider trading were listed as follows:

• An entrepreneur, a private equity investor and a venture capital general partner (walk into a bar?) investing in Cooper Tire;
• A former Fortune 500 exec and his brother-in-law;
• A former day trader, two of his friends and his brother-in-law (note to self, don’t talk freely in front of married-in family); and
• A Swiss trader

Were some hedge funds personnel charged with insider trading that year? I’m sure there were – there are some hedge fund personnel charged virtually every year. However, the fact is that the folks that get socked with insider trading come from all walks of financial and non-financial life. And even if EVERY case in FY2015 was a hedgie – it would still comprise less than 0.01% of the overall industry.

That’s right, a toilet injury is STILL more likely than hedge fund insider trading resulting in an enforcement action.

So if I’ve said it once, I’ve said it 1,000 times, but clearly it still bears repeating.

First, average not all hedge fund returns have lagged the S&P 500 in recent years. Some funds have done worse, some funds have performed well, and some have generated genuinely strong returns. Second, time periods matter. Third, the S&P 500 has been in a near-historic run-up and IS NOT HEDGED so it has no performance drag. Fourth, allegations of insider trading and hedge funds tend to be grossly exaggerated. And finally fifth – you’re pretty unlikely to get cat scratch FEVER from a sweet kitten – so visit your local shelter today.

Sources:

http://www.shape.com/lifestyle/mind-and-body/cat-scratch-disease-risk-prevention

http://www.care2.com/causes/youre-more-likely-to-be-injured-by-a-toilet-than-a-shark.html

http://factspy.net/40000-toilet-related-injuries-in-the-us-every-year/

http://www.bloomberg.com/news/articles/2016-10-14/hedge-fund-woes-after-u-s-crackdown-don-t-surprise-sec-s-chair

www.sec.gov

https://www.hedgefundresearch.com/hfri-indices-december-2015-performance-notes

https://www.sec.gov/about/secpar/secafr2015.pdf

Sleepless in Nashville

It’s that time of year again. The leaves are turning pretty colors. Kids are back in school. There is a real possibility of leaving my air-conditioned Nashville home without my glasses fogging upon hitting the practically solid wall of outdoor heat and humidity. And like any good Libra lass, I’m celebrating a birthday.

That’s right, it’s time for my annual orgy of champagne, mid-life crisis, chocolate frosting and introspection. Oh, and it’s time to check the batteries on the smoke detectors – best to make sure those suckers are good and dead before I light this many candles.

One of the things I’ve noticed in particular about this year’s “I’m old AF-palooza” is how much time I spend thinking about sleep. On any given day (and night), I’m likely to be contemplating the following questions:

1. Why can’t I fall asleep?
2. Why the hell am I awake at this hour?
3. How much longer can I sleep before my alarm goes off?
4. Why did I resist all those naps as a kid?

I even bought a nifty little device to track and rate my sleep (oh, the joy’s of being quantitatively oriented!). Every night, this glowy orb tracks how long I sleep, when I wake, how long I spend in deep sleep, air quality in my bedroom, humidity levels (in the South – HA!), noise and movement. 

To sleep, no chance to dream

Yes, I’ve learned a lot about my nocturnal habits from my sleep tracker – for example, I move around 17% less than the average user of the sleep tracking system, I’m guessing due to having two giant Siamese cats pinning me down - but the one thing I didn’t need it to tell me was that I SUCK at sleep.

I’m not sure when I went from “I can sleep 12 hours straight and easily snooze through lunch” to “If I fall asleep RIGHT NOW I can still sleep 3 hours before my flight….RIGHT NOW and I can still get 2.75 hours…1.5 hours….” but it definitely happened.

I don’t drink caffeine. I exercise. I bought a new age aromatherapy diffuser and something helpfully called “Serenity Now” to put into it. I got an air purifier, a new mattress and great sheets.

But no matter what I try, I am a terrible sleeper.

I’ve concluded that it must have something to do with stress. I do spend an inordinate amount of time thinking about life, the universe and everything, so perhaps that’s my problem.

So in honor of my 46th year on the planet, I decided to compile a list of the top 46-investment related things I worry about at night. They do say admitting the problem is the first step in solving it, after all.

In no particular order:

1. $2 trillion increase in index-tracking US based funds, which leads me to…
2. All beta-driven portfolios
3. Short-term investment memory loss (we DID just have a 10 year index loss and it only ended in 2009…)
4. “Smart” beta
5.  Mo’ Robo – the proliferation (and the dispersion of results) of robo-advisors
6. Standard deviation as a measure of risk
7. Mandatory compliance training - don’t I know not to take money from Iran and North Korea by now?
8. Spurious correlations and/or bad data
9. Whether my mom’s pension will remain solvent or whether I have a new roommate in my future
10. Politicizing investment decisions
11. Did I really just Tweet, Blog or say that at a conference?
12. Focusing on fees and not value
13. Robo-advisors + self-driving cars equals Skynet?
14. Going through compliance courses too quickly & having to do them over again
15. Short-term investment focus
16. Will I ever have to wait in line for the women’s bathroom at an investment event? Ever?
17. Average performance as a proxy for actual performance versus an understanding of opportunity and dispersion of returns
18. The slow starvation of emerging managers
19. Is my industry really as evil/greedy/stupid as it’s portrayed
20. Factor based investing – I’m reasonably smart – why don’t I get this?
21. Dwindling supply of short-sellers
22. Government regulatory requirements, institutional investment requirements and the barriers to new fund formation
23. “Chex Offenders” – financial advisors and investment managers who rip off old people (and, weirdly, athletes)
24. The vegetarian option at conference luncheons – WHAT IS THAT THING?
25. Seriously, does anyone actually read a 57-page RFP?
26. Boxes...check, style, due diligence...
27. Tell me again about how hedge fund fees are 2 & 20…
28. The markets on November 9th
29. The oak-y aftertaste of conference cocktail party bad chardonnay
30. Drawdowns – long ones mostly, but unexpected ones, too
31. Dry powder and oversubscribed funds
32. Getting everyone on the same page when it comes to ESG investing or, hell, even just the definition
33. Forward looking private equity returns (see also: Will my mom’s pension remain solvent)
34. Will my investment savvy and sarcasm one day be replaced by a robot (see also: Mo’ Robo)
35. After the election, will my future investment jobs be determined by my membership in a post-apocalyptic faction chosen by my blood type?
36. How many calories are in accountant-provided, conference giveaway tinned mints? (See also: conference chardonnay)
37. Why are financial advisors who focus on asset gathering more successful than ones that focus on investment management? #Assbackward
38. Dunning Krueger, the Endowment Effect and a whole host of ways we screw ourselves in investment decision making
39. Why divestment is almost always a bad idea
40. Active investment managers – bless their hearts – they probably aren’t sleeping any better than I am right now
41. Clone, enhanced index and replication funds – why can’t we just K.I.S.S.
42. The use of PowerPoint should be outlawed in investment presentations. Like seriously, against the actual law - a taser-able offense.
43. Will emerging markets ever emerge?
44. Investment industry diversity – why is it taking so looonnnnggg?
45. Real estate bubbles – e.g. - what happens to Nashville’s market when our hipness wears off? And is there a finite supply of skinny-jean wearing microbrew aficionados who want to open artisan mayonnaise stores that could slow demand? Note to self, ask someone in Brooklyn….
46. Did anyone even notice that hedge funds have posted gains for seven straight months?

Yep, looking at this list it’s little wonder that sleep eludes me. If anyone can help alleviate my “invest-istential” angst, I’m all ears. In the meantime, feel free to suggest essential oils, soothing teas and other avenues for getting some shuteye.

Sources and Bonus Reading: 

Asset flows to ETFs: https://www.ft.com/content/de606d3e-897b-11e6-8cb7-e7ada1d123b1

Recent HF Performance (buried) http://www.valuewalk.com/2016/10/hedge-fund-assets-flows/

HF Replication: http://abovethelaw.com/2016/10/low-cost-hedge-fund-replication-may-threaten-securities-lawyers/

Average HF Fees: http://www.opalesque.com/661691/Global_hedge_funds_slicing_fees_to_draw_investors169.html

Political Agendas & Investing: http://www.njspotlight.com/stories/16/10/03/murphy-adds-plank-to-platform-no-hedge-funds-in-pension-and-benefits-system/

Asset Gathering vs. Investment Mgmt: http://wealthmanagement.com/blog/client-focused-fas-more-profitable-investment-managers

World's Largest PE Fund: http://fortune.com/2016/10/15/private-equity-worlds-largest-softbank/  

Spurious Correlations: http://www.bloomberg.com/news/articles/2016-10-14/hedge-fund-woes-after-u-s-crackdown-don-t-surprise-sec-s-chair

Short-Term Thinking - 5 Months Does Not Track Record Make: http://www.cnbc.com/2016/10/14/venture-capitalist-chamath-palihapitiyas-hedge-fund-is-outperforming-market.html

Money Manager Advice: Don’t Panic, But Do Bring a Towel

Last week’s blog got me in a bit of hot water with some alternative investment folks I know. In fact, some thought it should have come with a lifetime supply of chocolate-covered Prozac to counteract the depressive, after-reading effects.

To answer the queries I seemed to receive en masse: No, I am not a defeatist. I am instead an optimistic pessimist – I’m often quite positive that the worst possible thing is bound to happen.

But just because I suggested last week that a few fund managers might have to (or want to) evaluate their long-term business viability in 2016 doesn’t mean I think this year is a total loss.

In fact, I’d say my best advice is, in the infamous words of Douglas Adams, “Don’t panic!” If you can do that and still somehow end 2016 knowing where your towel is, you’ve won.

But seriously, there are a number of positive developments for money managers that could play out this year. For example:

Market Volatility May Be Your Friend – If the stock market theme song post-financial crisis has been “Sweet Child of Mine”, 2016 has certainly changed its tune. Market volatility during the first two weeks of January brought me back to my high school-era living room, sitting in front of my (not flat-paneled) TV watching Axl Rose wiggle across stage belting out “In the jungle. Welcome to the jungle. Watch it bring you to your knnn, knnn, knnn, knnn, knees, knees. I want to watch you bleed!” That was one of my favorite videos back when, you know, MTV actually played music.

And while market volatility can be an exercise in white-knuckle, bile-producing, ‘how-will-I-ever-retire-now’ angst, it also offers investment managers an opportunity they haven’t really had since March 9, 2009: The chance to be a hero.

In a raging bull market, most performance looks like beta. No matter how well an active money manager does, the market can do it faster, cheaper and potentially better. A bull market is often a chump factory, no matter your talents.

And don’t get me wrong, I love a bull market because I am generally in better shape (shopping is, after all, my cardio), but a bull market doesn’t love active management. A down, sideways or otherwise volatile market creates what active money management really needs: Opportunity.

So play this one well, intrepid asset managers, and you could potentially see your breakthrough moment. And may the odds be ever in your favor.

The Fees Knees – Speaking of your knnn, knnn, knnn, knnn, knees, while the markets haven’t exactly been a jungle until recently, the fee debate certainly has.  There has been a barrage of class action lawsuits against Fidelity, Vanguard and others about excessive 401(K) fees. And if you Google “hedge fund fees” two of the top three responses are “Hedge Fund Performance Fees Decline Sharply” (FT) and “The Incredibly Shrinking Hedge-Fund Fee” (Bloomberg View).

Due at least in part to the inability of active managers to shine (see above), fees have become a inevitable battle ground for investors. When the rising tide lifts all ships, it becomes easier to confuse price with value.

But market volatility may help successful managers overcome near militant fee resistance, and interestingly enough, a new lawsuit against Anthem Inc. about low fee funds may help traditional active managers as well. 

 “An overriding theme of lawsuits attacking 401(k) plan fees is that they generally view the cheapest investment as being the most prudent investment choice fiduciaries can make for plan participants, according to Brad Campbell, counsel at Drinker Biddle & Reath and former head of the Employee Benefits Security Administration. That, Mr. Campbell said, is inconsistent with a fiduciary's obligations under the Employee Retirement Income Security Act of 1974, which indicates fees must be reasonable rather than the most inexpensive. According to the text of the new suit's complaint, “investment costs are of paramount importance to prudent investment selection,” which Mr. Campbell said is “an inaccurate statement of the law.” (http://www.investmentnews.com/article/20160112/FREE/160119984/401-k-suit-targeting-vanguard-fees-could-support-case-for-active)

After all, to misquote Brian Tracy, “The true measure of the value of any [money manager] is performance.”

Election Attention – And finally, in case y’all have slept through the proposed UK Trump ban, the Sanders-Clinton (oh, yeah, and O’Malley) poll mania, and impassioned pleas for walls around the country or just around Wall Street, you know we’re in an election year. Why is this a good thing? Well, for one, it’s wildly entertaining, although it does bring to mind PoliSci 401 “Those who seek power are not worthy of that power.” (Plato)

But really, it means the Eye of Sauron (read: regulatory and compliance entities) may be thinking about Wall Street, but it is unlikely that much will change this year, giving everyone a chance to continue working through compliance, operations, Form PF, AIFMD, and all of the other special gifts fund managers have gotten post 2008. Hell, someone may even come up with a way to streamline some of those processes during the short lull in activity and actually create some true economies of scale for struggling small funds. It’s MLK day (er, night) as I’m writing this so well, dammit, I have a dream.

In short, it ain’t all doom and gloom out there for the financial industry, but if this blog failed to convince you of that, I can only offer the following to answer any of your lingering doubts or questions.

42

The Wrong Barn Door?

Every Thursday there is a crisis at my house. A big one. It involves Hollywood movie scale running, hiding and yelling. The best FX team has nothing on the Matrix-like special effects that go on Chez MJ. And I can always tell the crisis is starting when I see this:

Yes, my Thursday Crisis is the Invasion of the House Cleaners. It’s scary stuff because, you know, vacuums and rags and spray bottles (oh my!).

How my cats learned to anticipate the Thursday Crisis is beyond me. I suppose there are subtle clues. I get up a little earlier to pick up and unload the dishwasher. (No judgment! I bet if I did a scientific poll about people who clean before their maids arrive the results would show I’m in the majority). I make a least one trip to the laundry room to grab clean sheets and towels. Whatever it may be, Spike and Tyrone have learned to watch for Thursdays with the diligence of Jack Nicolson guarding us against Cuban communism in A Few Good Men (“You can’t handle the vacuum!”).

For the rest of us, watching for the next financial crisis is a bit more nuanced. Last week, for example, I read two articles that made me wonder if we even understand what a crisis is, or if we all believe financial panic is as predictable as my housecleaners’ arrival.

The first article looked at the state of venture capital in the U.S. New figures, released by PriceWaterhouseCoopers and the National Venture Capital Association showed that venture capital investments in companies reached $17.5 during the second quarter of 2015, their highest totals since 2000. However, the article argued that, given that the total projected investment for 2015 (more than $49 billion) was less than the total amount invested in 2000 ($144 billion) and that the number of deals is lower as well, it couldn’t be another tech wreck-venture capital bubble in the making.

The second article looked at the risk precision of Form PF – a document introduced post-2008 to better understand and measure the risks created by hedge funds. The article cited two instances where hedge funds had proven their ability to destabilize economies: George Soros’ attack on the GBP in 1992 and Long Term Capital Management, the first "too big to fail", in 1998. Given that the hedge fund industry is now much larger than it was during those two “crisis”, it of course stands to reason that the risks created by hedge funds are now exponentially greater as well.

Or are they? 

Both articles were extremely interesting and presented compelling facts and figures, but they also were intriguing in that both seemed to assume that, at least in part, we experience the same crisis repeatedly. That perhaps we have a financial boogeyman waiting outside of the New York Stock Exchange every Thursday, much like my housecleaners.

But the reality is, a crisis is often a crisis precisely because we don’t see it coming. Each meltdown looks different, however subtly, from the one that went before. Which begs two questions:

1. Are we always slamming the barn door after the horses are gone?
2. And going forward, are we even worried about the right barn door?

Let’s look at a few financial meltdowns as examples.

1987 – Largely blamed on program trading by large institutions attempting to hedge portfolio risk.

1990s – Real estate crisis caused by market oversupply.

1998 – Asian markets (1997) plus Russia plus Long Term Capital Management– a hedge fund leveraged out the ying yang (technical term).

2000-2002 – The tech wreck. Could be blamed on “irrational exuberance”, changes to tax code that favored stocks with no dividends, or excessive investment in companies with no earnings (or products in some cases).

2008 – Credit meltdown created largely by overleveraged consumers and financial institutions.  Real estate crisis created by demand (not supply).

2011 – Sovereign credit issues, not a total meltdown obviously, but noticeable, particularly in many credit markets.

While these are gross oversimplifications of each period, it does show a clear pattern that, well, there ain’t much of a clear pattern. Bubbles happen largely due to macro-economic investor psychology. Everyone jumps on the same bandwagon, and then decides to jump off at roughly the same point. Think of it as Groupthink on a fiscal level. It isn’t easy to break away from Groupthink and it’s often even harder to spot, given that we’re often part of the group when the bubble is building.

So what’s the point of this little rant? Do I think we’re at a new venture capital bubble? I don’t know. The market has changed dramatically since 2000 – crowdfunding, Unicorn Watch 2015, lower costs for startups, and shows like “Shark Tank” are all evidence of that, in my opinion. And are hedge funds creating systemic risk in the financial markets? I don’t know the answer to that question either, but ETFs have now eclipsed hedge funds in size and robo investors are gaining ground faster than you can say “Terminator,” and LTCM was nearly 20 years ago, so it seems unlikely that hedge funds are the sole weak spot in the markets.

I guess I said all that to say simply this: If we spend too much time trying to guard ourselves against the problems we’ve already experienced, we’re unlikely to even notice the new danger we may be facing. If my cats only worry about Thursdays, what happens if the plumber shows up on Tuesday? Panic. If you drive forward while looking behind you, what generally happens? Crash.

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Sources: http://www.entrepreneur.com/article/248784, http://www.ibtimes.com/hedge-fund-risks-may-be-bigger-regulators-know-despite-dodd-frank-2033322

Rampallions & Scullions & Hedge Funds, Oh My!

Last week, MarketWatch ran an OpEd on hedge funds that managed to insult nearly every participant in the financial marketplace. Hedge funds were described as “dethroned kings” ruling over an “empire of fools.” Hedge funds are a “cautionary tale” filled with insider trading, poor performance and investor backlash. Why, it is so bad that investors are no longer “dazzled” and hedge funds may be as bad as (gasp!) mutual funds.

I read that article with its virtually Shakespearean array of insults and actually wondered where the author keeps his money. Some folks have wagered it’s either under the bed or in Bitcoin, although I suppose there’s a slight chance it could be in a sock in the freezer. (Friendly note: that’s one of the first places that a thief will check.)

For those of you that are regular readers of my blog, you know that I’ve dealt with a number of the assertions in this article before. Let’s start with performance. There are few places where the phrase “Your Mileage May Vary” is as applicable as it is in the world of hedge funds. While there is no doubt that the average hedge fund return was anemic in comparison to the (insert sarcasm here) infallible S&P 500, an average provides merely that – the arithmetic mean of the top and bottom performers (and everything in between).

Assuming that all hedge funds generated lackluster returns because the average hedge fund did is just, well, silly. You can look at articles such as this CNBC piece or this ZeroHedge article to see hedge funds that didn’t just outperform their industry average, but kicked the pants off of the S&P 500 as well. There were funds that were up 30 percent, 40 percent, 50 percent 60 percent or more, to which I simply say “Thank you, sir, may I please have another?”  (And for those of you that are wondering, that's from Animal House, not Fifty Shades of Grey.)

For more information on The Truth About Hedge Fund Performance, check out my video blog from last quarter.

I’m also not going to get too deeply into the fee equation as I’ve touched on that a time or two as well. I think the last time was a mere two weeks ago in a blog post about duct tape.

But I have to say, what really buttered my toast this time around was the assertion that, in addition to being greedy underperformers, hedge funds have the corner on the insider trading market as well. The hedge fund inclination to insider trading came up twice in MarketWatch’s short post.

So before we start to tar hedge funds with that particular brush, let’s look at SEC data on enforcement actions, shall we?

The chart below shows all SEC enforcement actions across type and year. Note that insider trading is a relatively small category of enforcement actions. Year over year, insider trading accounts for an average of less than 8 percent of the actions of the SEC, with an average of about 50 insider trading enforcement actions per year.

Source: www.sec.gov

Now, even if ALL of the insider trading was committed by hedge funds, it would still represent a very small proportion of the hedge fund world. Take the ever-present 10,000 fund estimate that the industry favors: If all 50 of those annual insider trading schemes occurred in a hedge fund, then 0.05 percent of hedge funds would in fact be knaves and rapscallions.

But we know that insider trading is not solely committed by hedge funds. How do we know? We can again check out www.sec.gov and get a sense of who does commit this crime. Some of my particular favorites? Accounting firm partners, amateur golfers, vitamin company former board member, drug trial doctors, former BP employee, two husbands, Green Mountain Coffee employee, and the list goes on. And it’s true that some of these folks made millions in ill-gotten gains, although one guy got only $35,000 and a jet-ski dock. That dude must LOVE to jet ski.

Look, I’m not saying that some hedge fund managers haven’t done bad things. There certainly are hedge funds represented on the insider-trading list, and just today there was an article on a manager that faked his death to avoid paying back investors. But shenanigans aren’t limited to hedge funds and finance. For example, cell phone companies generate about 38,420 complaints per year, in comparison.

At the end of the day, I just wonder how good it is for the finance industry or for investors to totally defame the entire investment industry and slam hedge funds in particular. I am a fan of exploring all my investment options. Attempting to remove those options through “fund shaming” is ultimately bad for me and other investors. To the extent this kind of misinformation impacts inflows, encourages closures and causes qualified investors to dismiss hedge funds out of hand, it can only result in fewer investment options, lower returns and higher correlations and volatility. 

In Case You Missed Them - 2014 Blogs By Topic

In case you missed any of my snappy, snarky blogs in 2014, here is a quick reference guide (by topic) so you can catch up while you gear up for 2015. My blog will return with new content next Tuesday – starting with my "New Year’s Resolutions for Managers and Investors."

“How To” Marketing Blogs

http://www.aboutmjones.com/blog/2014/12/8/anatomy-of-a-tear-sheet

http://www.aboutmjones.com/blog/2014/11/12/emerging-manager-2015-travel-planner

http://www.aboutmjones.com/blog/2014/10/21/conference-savvy-for-investment-managers

http://www.aboutmjones.com/blog/2014/9/11/ten-commandments-for-pitch-book-salvation

http://www.aboutmjones.com/blog/2014/7/18/emerging-managers-the-pitch-is-back

Risk

http://www.aboutmjones.com/blog/2014/11/10/look-both-ways

http://www.aboutmjones.com/blog/2014/11/3/the-honey-badger

General Alternative Investing

http://www.aboutmjones.com/blog/2014/10/25/earworms-and-investing

http://www.aboutmjones.com/blog/2014/10/7/alternative-investment-good-newsbad-news

http://www.aboutmjones.com/blog/2014/9/17/pay-what

http://www.aboutmjones.com/blog/2014/7/21/investing-and-the-law-of-unintended-consequences

 “The Truth About” Animated Blogs – Debunking Hedge Fund Myths

http://www.aboutmjones.com/blog/2014/10/13/the-truth-about-hedge-fund-correlations

http://www.aboutmjones.com/blog/2014/9/6/the-truth-about-hedge-fund-performance

http://www.aboutmjones.com/blog/2014/8/8/the-truth-behind-hedge-fund-failures

Diversity Investing

http://www.aboutmjones.com/blog/2014/12/8/getting-an-edge-in-private-equity-and-venture-capital

http://www.aboutmjones.com/blog/2014/11/21/the-simple-case-for-emerging-managers

http://www.aboutmjones.com/blog/2014/9/29/mi-alpha-pi-a-look-at-the-sources-of-alpha

http://www.aboutmjones.com/blog/2014/7/21/affirmative-investing-putting-diverse-into-diversification

Private Equity and Venture Capital

http://www.aboutmjones.com/blog/2014/12/8/getting-an-edge-in-private-equity-and-venture-capital

Emerging Managers

http://www.aboutmjones.com/blog/2014/11/21/the-simple-case-for-emerging-managers

http://www.aboutmjones.com/blog/2014/11/12/emerging-manager-2015-travel-planner

http://www.aboutmjones.com/blog/2014/9/29/mi-alpha-pi-a-look-at-the-sources-of-alpha

http://www.aboutmjones.com/blog/2014/8/25/submerging-managers

Will Accreditation Changes Turn Emerging Managers into Submerging Managers?

Most of my non-industry friends don’t know what I do. They all know that I do research in finance, but to most, my alternative investment research focus is as mysterious as if I was a pre-Snowden NSA operative. This is in part because many of them consider finance to be frightfully dull. However, the primary reason for their lack of knowledge is something called "accreditation."

The SEC restricts data on and investments in hedge and PE funds (as well as other private investments) to those folks that are “accredited investors.” For decades, being an accredited investor has meant either having a million dollar net worth (excluding your primary residence) or an income of $200k/$300k (single/married). These income and net worth standards are used as a proxy for financial savvy. If you have enough in the bank, then you must understand money, the SEC reasons, and therefore you are allowed to take more risks with your cash.

However, even as I type, the Securities and Exchange Commission Investor Advisory Committee is weighing changes to accreditation standards. Some of the considerations on the table include raising the income threshold to $500,000 and the net worth threshold to as much as $5 million. In addition, there has been mention of a financial literacy requirement, such as passing the Chartered Financial Analyst exam. The monetary requirements would wipe out a huge portion of the HNW investor community, while a CFA requirement would take out a significant portion of the rest. For example, increasing the net worth requirement from $1 million to just $2.5 million would reduce the accredited HNW investor base from 8.5 million to 3.4 million people according to some studies. (http://www.cnbc.com/id/101933881)

While I understand the urge to “protect” investors, I happen to think these changes are unwarranted and may potentially have a significantly negative impact on innovation and diversity, and ultimately returns, within the alternative investment industry. And frankly the proposed changes just raise a lot of questions for me.

Why this particular threat?

There are a number of financial arenas in which enhanced knowledge, wealth or sophistication could make a material difference in outcomes. For example, according to one study, 15% of all bankruptcies are caused by credit debt, including credit cards, large mortgages, and car payments (http://assets.clearbankruptcy.com/infographics/leading-causes-of-bankruptcy.jpg).

In 2010, there were nearly 1.6 million bankruptcies. So approximately 240,000 Americans potentially could have avoided bankruptcy if the government controlled how much credit one could obtain, how much creditors could extend, or how well people have to understand credit before taking on such burdens.

Likewise, look at day traders. In order to manage a pattern day trading account, one must maintain a mere $25,000 balance. Yet, one study showed that four out of five day traders lose money, while another determined only one out of every 100 day traders consistently make money. Let’s assume that roughly 10,000 people in the U.S. day trade as their primary job. Of those professional day traders, 100 consistently make money and the other 9,900 consistently lose. Why not regulate this more closely? Maybe require a CFA?

And don’t get me started about gambling or the lottery. According to a Gallup Poll on Gambling, 57% of American adults reported playing the lottery in the last 12 months, with 65% of those falling into the $45,000 to $75,000 income bracket (http://www.naspl.org/index.cfm?fuseaction=content&menuid=14&pageid=1020#LotteryOdds) Your chances of winning the lottery? Less than getting injured by your toilet this year, according to National Geographic. How many folks do you think really understand those odds?

Hell, the average investor can contribute to a Kickstarter campaign for potato salad (over $40,000 raised) or a Chipolte burrito ($1050) which are both completely stupid investments AND utterly unregulated. Or what about Bitcoins? Mt. Gox lost over $409 million for its clients.

In short, there is no end to the ways you can “invest” your money. And any way you slice it, there are plenty of ways that these investments can destroy your wealth. Why doesn’t the federal government care about the “sophistication” required to understand, withstand and mitigate other "investment" risks, particularly ones that have a lot lower chance of success?

Isn’t this a self-limiting problem?

 If this is aimed specifically at hedge funds and private equity, the issue of high net worth investors putting all of their cash into “risky” investments is somewhat limited by the structure of the funds themselves. With high investment minimums (generally between $250,000 to $1 million), it is unlikely that a “lower level” high net worth investor will be able to make more than one investment, if that. For some who are early stage “friends and family” money, those investment minimums may be waived, but then the potential “damage” is mitigated as well. Most managers don’t want a fund filled with small investors (more work, less capital), so they tend to limit small investments. The market forces alone seem to be pretty efficient at limiting the hedge fund investments of your average millionaire in this case.

Won’t this submerge emerging managers?

 One of the arguments to make these accreditation changes is that no one has really squawked about them yet. Of course, this doesn’t take into account that the funds that have the financial wherewithal to actually make a fuss probably won’t even notice. There are about 500 funds that have more than $1 billion or more under management. There are about 5,000 funds that manage less than $100 million. As you look across this size spectrum of funds, the importance of the high net worth investor decreases as the size of the fund increases. Generally speaking, larger funds tend to be better influencers and squeaky wheels. Its likely HNW investors just aren’t a very important part of a large fund's business model any more.

And for those that say HNW isn’t important to the entire industry, it is true that about 65% of the AUM in the hedge fund industry now comes from institutional investors. It’s also true, however, that virtually none of that is in the emerging fund (small, new, women or minority owned) manager category. The 35% of assets that are controlled by HNW and family offices remains vitally important to this group of fund managers. Without access to a significant pool of HNW capital, and specifically early stage “friends and family” capital, many emerging funds might never, well, emerge.

Why do we care? Smaller managers can produce higher returns. Smaller managers can provide liquidity to parts of the market that are ignored by larger funds. Smaller funds may innovate where larger funds may care-take. Limiting opportunities in the emerging manager space is a key step towards the homogenization of the industry.

Will there be any unintended consequences?

Angel investors who help small businesses launch, fund innovation and create jobs would be swept up in this as well.

Of course, I imagine the SEC cares about as much about my opinion on accreditation as my non-industry friends do. So after today's blog, I'm only talking about beer, boats and BBQ. At least until after Labor Day. Enjoy the long weekend, y'all!